IRS as Nonprofit Oversight? Without a Lot More Help, Don’t Expect Much

Boston College law professor Ray Madoff warns that reductions in the IRS budget have manifested as an inability of the tax-exempt organizations unit to properly monitor either the quality of applications being submitted for tax-exempt status or the behavior of those organizations once that status is afforded. We agree that pressures on the agency have created systems that fail to foresee problems with applicants even in the face of discernible evidence. However, some of this spotty monitoring has been longstanding, and not even the promise of automated detection systems has led to improvement.

The IRS budget has been cut from $13.8 billion in 2010 to $11.5 billion in 2017 (adjusted for inflation). That’s a 17 percent reduction that translates into staff reductions from 101,000 in 1997 to 76,800 in 2017, or a 25 percent cut. Madoff connects this to the unit’s selection of an expedited process for nonprofit approvals that’s based less on proof than assertion. It’s a combination she believes is bad news for ferreting out those using nonprofits as vehicles for fraud. When the IRS does not have the staffing or budget to monitor the sector, she says, it fosters a culture of noncompliance.

In 2014, its first year, the new 1023-EZ form designed for new 501c3 groups with small budgets, which requires no supporting documentation, drew 100,000 new applications for tax exemptions; last year, the division rejected just 37 of the 79,582 applications on which it made a final determination.

A study by the Taxpayer Advocate Service at the IRS later found that more than a third of the groups surveyed were not qualified to use the EZ form and should not have been approved. The advocate service said there was “a disturbing lack of information” about the new groups, which threatened to undermine “the public’s and the IRS’s ability to effectively monitor this segment of the exempt organization population.”

Last year, Michael Wyland did a deep dive into what both the IRS’ EZ application processes and revocation processes left behind and one of the trends he documented was the increasing use of the EZ form. (In 2017, 65 percent of all applications for tax exemptions were made via this form.)

Karen Hensel and Douglas Moser use the Key World Foundation, the charity at the center of the college admissions scandal, as an example of the problems caused by inadequate detection at the IRS. Key operated since 2012 without raising any red flags at the IRS. The FBI uncovered the case based on a tip from an unrelated securities fraud investigation that led to a college coach at Yale who cooperated with investigators. This dynamic is relatively common—alarm over a fraud in nonprofit garb is sounded first not at the IRS, but by another enforcement agency or the media. Also in the enforcement mix are state charity offices, which are often housed in state attorney-general offices, and the FTC. Might a laxer application process cause more problems? Absolutely, but when it comes to larger frauds, it’s often not the IRS that rings the bell, as Cindy Lott discusses in a 2016 interview with NPQ.

Of course, the IRS does do its share of auditing, both of individual agencies and fields, as was recently evident when Iowa Senator Chuck Grassley requested an update of a long-term study of the community benefits programs of nonprofit hospitals. But, it’s seldom as much those who see the value in this kind of oversight would want, or as general in scope. Even under the budget cuts, a few years ago, the agency promised that it was headed to the use of algorithmic detection systems; if these have been in active use, they haven’t made a big splash.—Eric Fullilove and Ruth McCambridge

About Eric Fullilove

Eric Fullilove joined Relief International in 2018 as Chief Financial Officer. Eric is an MIT graduate, a Certified Public Accountant and a published author. He has had broad experience in the both the for-profit and nonprofit sectors. Eric has held leadership positions at organizations including World Vision, where he was global CFO with responsibility for Global Finance, IT, Supply Chain, Shared Services and Corporate Real Estate. He also has worked in a variety of organizations, including: Housing Works, a New York City provider of housing and services for people with AIDS and HIV; Teach for America, which provides teachers to under-resourced urban and rural school districts; and Boys and Girls Clubs of Santa Monica, which provides enrichment and leadership training for youth.

About Ruth McCambridge

Ruth is Editor in Chief of the Nonprofit Quarterly. Her background includes forty-five years of experience in nonprofits, primarily in organizations that mix grassroots community work with policy change. Beginning in the mid-1980s, Ruth spent a decade at the Boston Foundation, developing and implementing capacity building programs and advocating for grantmaking attention to constituent involvement.